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Morgan Housel and Fungibility



November 09, 2013 – Comments (0)

As usual, we can count on Morgan Housel to lay something out that knocks us off our various dimes.  I especially appreciate the posted commentary as it relates to valuation.  What I can't let go of is the confluence of debt, leverage and the fungibility of money.  

banmate7 points out that the 2007 crash was not due to overvalued share prices, but something else (unlike the 2000 tech bubble).  That something else was leverage and debt as he points out.  That leads to a couple of points, which I'll circle back to other comments on Morgan's post.

1. GDP = C+I+G+NE

but GDP is also measured

2. GDP = Money Supply X Velocity

The two measures are intertwined, particularly as it relates to G, Government Spending.  Government spending moves money through the economy, which is where xetn's comment falls apart when he asserts that the G is a false measurement.  In 2007, the financial breakdown brought Velocity to a standstill.  Government intervention was required because everybody was seeing the amount of money they have evaporate (fungibility).  If we have less money, who is going to be the first to push theirs through the economy?  Warren Buffett did what he could, but even he didn't have the trillions necessary to move the whole world.  

And it was the whole world that was the problem.  As world economies grew over the preceding decade or so, the world money supply grew at an astounding rate relative to history.  If I accurately recall the Mauldin article sometime around 2005  or 2006, global money expanded from mid-thirty-something trillion dollars to double that in about 10 years.  As any Econ 101 student knows, debt is a primary driver of growth.  We need to borrow money to invest in our businesses, our educations, etc.  This borrowing creates paper wealth, always subject to fungibility.  As long as the value of a buck remains constant (or ideally, inflates, if you are the borrower), we have a system of agreeable parties playing the same game.  Throw in a bad actor however, say mortgage backed bonds built upon lies, and suddenly we see the collapse of the game; fungibility leads to deflation and destruction of asset values (and also, debt).

So what?  Well, I would posit that GDP was built too strongly upon finance and financial instruments. Growth of the global money supply reflects excess debt and (more perniciously) leverage.  Back to Econ 101 and the lessons of the fungibility of money; collapse of the economic balloon, filled with helium made of debt and leverage makes every one of our dollars less valuable.

Now what?  Well, it's notoriously difficult to find current estimates of world money supply, but I bet it has not reverted to anywhere near the mean.  This can happen only through debt destruction (asset devaluation...see "underwater mortgage" and "Greece"), which was strong and sure there for a couple of years.  But if you are a home owner and your home equity has returned to 2007 levels (it has in most parts of the country), then you now the money balloon has been reflated by the worlds central banks.  Therein lies pent up danger.

So while we debate whether Amazon is a good stock to buy at this juncture, we should imagine what any of it is really worth...we can't eat it, we can't shelter under it and we can not clothe ourselves with any of it.  

It's entirely fungible.  Econ 101.  So, take it away you existential capitalist philosophers! 

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